What do a giant German lender with global ambitions and a small Mediterranean retailer overloaded with costs and rotten loans have in common? Nothing, except for one thing: they are both problems that European Central Bank supervisors seem unable to solve.
Deutsche Bank, a backbone of Germany’s economic miracle, found itself at a crossroads at the start of this millennium. One avenue led to more of the same: helping domestic exporters win international markets. The other appeared more attractive: growing through acquisitions to join the elite global investment banks. It chose the latter.
After the 2008 financial crisis, Deutsche Bank again faced a choice: taking losses and retreating or doubling down. Once more it went for the risky option. Some of its new bets later led to regulatory penalties and lawsuits.
Eventually, the bank adopted a mix of raising capital, cutting costs and gradually scaling back risky exposures. But this defensive strategy failed to convince the market: price-to-book values kept sliding. The restructuring announced in July is hardly decisive: toxic portfolios are not definitively transferred out of the balance sheet, and the promised end of share trading may conflict with the bank’s intention to maintain investment banking support to German corporates. Fundamentally, focusing on domestic retail does not seem a promising avenue in the overcrowded German market. It also exposes the bank to further interest rate cuts by the ECB.
Five hundred miles to the south, meanwhile, you will find Banca Carige. Worth less than 2 per cent of its German peer in assets, this lender, founded in 1483, once prospered by enjoying a near-monopoly in the Ligurian region, and an amicable relationship with politics and the church. In the 1990s its life changed. Virtually unchecked by regulators, it recklessly expanded in real estate, insurance and illicit operations, while granting generous credit to friendly but unworthy borrowers.
Here too, the financial crisis was a watershed: in 2014 the bank failed its ECB asset-quality reviews. A belated management overhaul proved insufficient. Short of capital and occasionally of funding, the bank was put by the ECB under special administrators tasked with preparing a business plan to garner investor support. A domestic rescue is being prepared, supported by the national deposit insurance fund and a mix of small and public lenders. No new business plan, asset-quality review or stress test is available. The bank has announced half-year losses more than five times its market value.
A common thread behind such diverse banking misfortunes is that they are supposed to be addressed — and hopefully prevented — by timely application of a supervisory menu including conservative and transparent balance sheet reviews, signing off business plans and tough capital and liquidity requirements. A Single Supervisory Mechanism was launched in Europe in 2014 largely to ensure that this menu would be applied to banks consistently and in an even-handed way. The new supervisory approach was to be upheld by a new area-wide resolution framework to keep systemic risks in check.
One might ask why the ECB supervisor seems hesitant in serving up that menu. It is not due to incompetence or lack of awareness: the ECB houses hundreds of experienced, dedicated supervisors. But their best efforts clash with fundamental weakness in the underlying laws and the “resolution” framework for dealing with ailing banks.
Legislation is a central pillar of bank supervision because, in the end, supervisory decisions can be challenged in court for failing to comply with the law — and they often are. The ECB is specifically required to apply not only its own charter, an EU regulation, but also national laws, including some that make it hard to be tough about non-performing loans and other soundness issues.
The EU’s resolution framework also makes it hard for responsible supervisors to do their jobs properly. It has limited authority and only a small (and as yet unused) rescue fund and limited ability to inflict losses on bank bondholders. Supervisors are chary of taking tough action against fragile banks — they cannot be sure what will happen if one does go bust.
New institutions, especially those as important and broad-ranging as those which make up the banking union, must demonstrate that they help solve the problems they were created to address. If they do not, sooner or later existential questions will be raised. It would be better to fix the shortcomings now, before this happens.
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